Mark to Market Explained

“Mark to market” is one of those confusing terms that’s been thrown around discussions of the finance meltdown. It’s basically an accounting rule that means that a company has to put value certain assets on its balance sheet (in other words, to “mark”) at what the market says their worth.

“Fair value” accounting rules require banks to value certain loans and securities on their books — those that they don’t intend to hold forever — at the price that they are currently trading at on secondary loan markets. That’s generally a sound idea when those markets are working well. But now that those markets have virtually collapsed because there aren’t enough buyers, prices have plummeted well below what their economic value would be if held until maturity. Requiring banks to use artificially depressed values is making a bad situation even worse.

Given the market situation, banks want to be able to ignore market prices and use their own models to guess at the economic value of the securities. That might make the banks’ financial statements look stronger, but might not do much to restore investor confidence. Financial institutions have dragged their feet in acknowledging the extent of their losses in real estate and other lending, and many investors and regulators now believe they can’t be trusted to come up with credible alternatives to market prices, as imperfect as they may be. Moreover, without credible financial statements, it would only get harder for the banking system to attract new capital.

The bill defeated by the House did not ignore the accounting issue. It ordered the Securities and Exchange Commission to move quickly to study the issue and granted the agency the power to immediately suspend the mark-to-market rule.

There is an easy compromise here: Require banks to disclose market prices right alongside their own estimates of “fair value.” Let the investors decide which to rely on.